Gambler’s Fallacy – An Investment Version by Matt Brice, The SOVA Group
Gambler’s Fallacy has something to do with events and frequency. You can read about it here. My version of gambler’s fallacy is that people associate the statistical risk/reward relationship of poker with investing in order to justify playing poker because….”Hey, I am working because Poker is like investing.”
If you want to play poker, just play.
I wrote a while back about Andrew Beal. He runs Beal Bank in Texas that, from all accounts, has a tremendous record. He is also a huge poker player. You can read the book, Professor, Banker and Suicide King about his adventures in the high stakes world of poker. It is an interesting read on poker, not much about investing or his business story, however.
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
I have two main problems with Poker and the tenuous connection to investing. Given my limited Poker playing, I could be totally off-base here.
First: In poker, when you have the best possible hand, betting a lot does not get you much in return. If you go all-in, inevitably, most will see that you probably have a good hand, and therefore fold. That just doesn’t happen in the markets. Unless you are moving markets with you investment positions, investing heavily when you have a great opportunity, will give you a great reward.
Second, Poker is mostly a closed-system. There are 52 cards, and depending on how many players, you can calculate the odds of your success based on your cards and what others might have. If you have 3 aces, you know what can beat you, and what can’t beat you. You might calculate that there is one hand that can beat you and there is a 2% chance that your opponent has those cards. There is mathematical precision in that calculation and it is accurate. Your opponent may end up have the cards that beat you, but since there was a 2% chance, you understand that it was a possibility.
This is where my biggest beef with poker and investing lies. Investors frequently use these precise probabilities and odds in investing, when I don’t see any evidence that this precision is justified. Investing, unlike poker, is not a closed-system. There are not 52 cards with X amount of combinations. There are a multitude of possibilities with any number of different actors influencing those possibilities on a daily basis. There is nothing that raises my BS indicator more quickly than the following phrase, “We see a 70% probability of a 40% appreciation in the stock and only a 30% probability of 10% downside, therefore the risk/reward is favorable.” Where did these numbers come from–the dart board in the local bar?
Beware of the false gods of precision…
Since it is Super Bowl week, I thought I would share this feel-good story…”From parking cars to playing in the Super Bowl in under a month.” See here. What are the odds on that….?